Rolls-Royce shares: 1 reason to buy and 1 reason to sell

The Rolls-Royce share price has yet to recover anything substantial. Might August’s first-half results give it a much-needed boost?

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Rolls-Royce (LSE: RR) was one of the companies hardest hit by last year’s stock market crash. It didn’t really partake in the late 2020 recovery either. And the Rolls-Royce share price is still down around 65% over the past two years.

Pandemic meant lockdown, lockdown meant nobody flying. Nobody flying meant no aircraft engine maintenance. Well, there was some, but well below normal levels. But with the end of Covid restrictions moving ever closer, many are heading off on their hols again.

And that’s my chosen reason I’d think of buying Rolls-Royce shares. In a recovery situation, I want to see a troubled company’s business starting to pick up again. Or, at least, strong indications it’s about to happen any day now. I’m hoping we’ll see some hard evidence of recovery with first-half results, due on 5 August.

Rolls-Royce share price: ready for the rebound?

I think we might see a spark of interest in the Rolls-Royce share price in the days leading up to that. But in the meantime, I’m buoyed by the firm’s AGM statement from May.

Chief executive Warren East said: “Looking ahead, we are confident that the significant restructuring actions we have taken in 2020 will deliver permanent cost reductions, positioning us well for the rebound in international air travel.

So we have a leaner and more cost-efficient Rolls-Royce now, and that’s maybe not a bad thing anyway. I’ve always liked the company ,and from this direction it looks like a ‘buy’. But what’s the other angle, and why might I rate it a sell? In a word, cash.

Rolls-Royce needed to take on a whole new financing deal just to keep going. Part of that involved raising around £2bn from disposals. But the company also raised £7.3bn from new debt and equity. That was in a year that resulted in a pre-tax loss of £2.9bn, and a free cash outflow of £4.2bn.

Share price valuation

Those are scary, scary numbers. And they make all previous valuation metrics utterly meaningless. With the degree of restructuring that’s been needed, we’re essentially looking at an an entirely new version of Rolls-Royce now. And it’ll surely take some time for markets to settle on a sensible long-term valuation. It’ll definitely take me some time to work out where I think the Rolls-Royce share price should be.

I can’t see things settling this year. The company said it’s targeting positive free cash flow in the second half of 2021. And it hopes to reach at least £750m by 2022. If that comes off, my confidence will be boosted. But there’s still significant risk here. And my biggest fear is that the cash could run out and Rolls-Royce might need further financing.

If that happens, a resulting combination of more debt and more equity dilution would throw all valuation measures further up in the air again. Hopefully, we’ll get a clearer idea of how the financial picture is looking once we have those H1 figures. Until then, I’m just watching.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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